Weekly Issue: Key Developments at Apple (AAPL) and AT&T (T)

Weekly Issue: Key Developments at Apple (AAPL) and AT&T (T)

Key points inside this issue:

  •  Apple’s 2019 iPhone event – more meh than wow
  •  GameStop – It’s only going to get worse
  •  Elliot Management gets active in AT&T, but its prefers Verizon?
  •  California approves a bill that changes how contract workers are treated
  • Volkswagen set to disrupt the electric vehicle market

I’m going to deviate from the usual format we’ve been using here at Tematica Investing this week to focus on some of what’s happening with Select List residents Apple (AAPL) and AT&T (T) this week as well as one or two other things. The reason is the developments at both companies have a few layers to them, and I wanted to take the space to discuss them in greater detail. Don’t worry, we’ll be back to our standard format next week and I should be sharing some thoughts on Farfetch (FTCH), which sits at the crossroads of our Living the Life, Middle Class Squeeze and Digital Lifestyle investing themes, and another company I’ve been scrutinizing with our thematic lens. 

 

Apple’s 2019 iPhone event – more meh than wow

Yesterday, Apple (AAPL) held its now annual iPhone-centric event, at which it unveiled its newest smartphone model as well as other “new”, or more to the point, upgraded hardware. In that regard, Apple did not disappoint, but the bottom line is the company delivered on expectations serving up new models of the iPhone, Apple Watch and iPad, but with only incremental technical advancements. 

Was there anything that is likely to make the average users, not the early adopter, upgrade today because they simply have to “have it”? 

Not in my view. 

What Apple did do with these latest devices and price cuts on older models that it will keep in play was round out price points in its active device portfolio. To me, that says CEO Tim Cook and his team got the message following the introduction of the iPhone XS and iPhone XS Max last year, each of which sported price tags of over $1,000. This year, a consumer can scoop up an iPhone 8 for as low as $499 or pay more than $1,000 for the new iPhone 11 Pro that sports a new camera system and some other incremental whizbangs. The same goes with Apple Watch – while Apple debuted a new Series 5 model yesterday, it is keeping the Series 3 in the lineup and dropped its price point to $199. That has the potential to wreak havoc on fitness trackers and other smartwatch businesses at companies like Garmin (GRMN) and Fitbit (FIT)

Before moving on, I will point out the expanded product price points could make judging Apple’s product mix revenue from quarter to quarter more of a challenge, especially since Apple is now sharing information on these devices in a more limited fashion. This could mean Apple has a greater chance of surprising on revenue, both to the upside as well as the downside. Despite Apple’s progress in growing its Services business, as well its other non-iPhone businesses, iPhone still accounted for 48% of June 2019 quarterly revenue. 

Those weren’t the only two companies to feel the pinch of the Apple event. Another was Netflix (NFLX) as Apple joined Select List resident Walt Disney (DIS) in undercutting Netflix’s monthly subscription rate. In case you missed it, Disney’s starter package for its video streaming service came in at $6.99 per month. Apple undercut that with a $4.99 a month price point for its forthcoming AppleTV+ service, plus one year free with a new device purchase. To be fair, out of the gate Apple’s content library will be rather thin in comparison to Disney and Netflix, but it does have the balance sheet to grow its library in the coming quarters. 

Apple also announced that its game subscription service, Apple Arcade, will launch on September 19 with a $4.99 per month price point. Others, such as Microsoft (MSFT) and Alphabet (GOOGL) are targeting game subscription services as well, but with Apple’s install base of devices and the adoption of mobile gaming, Apple Arcade could surprise to the upside. 

To me, the combination of Apple Arcade and these other game services are another nail in the coffin for GameStop (GME)

 

GameStop – It’s only going to get worse

I’ve been bearish on GameStop (GME) for some time, but even I didn’t think it could get this ugly, this fast. After the close last night, GameStop reported its latest quarter results that saw EPS miss expectations by $0.10 per share, a miss on revenues, guidance on its outlook below consensus, and a cut to its same-store comps guidance. The company also shared the core tenets of a new strategic plan. 

Nearly all of its speaks for itself except for the strategic plan. Those key tenets are:

  • Optimize the core business by improving efficiency and effectiveness across the organization, including cost restructuring, inventory management optimization, adding and growing high margin product categories, and rationalizing the global store base. 
  • Create the social and cultural hub of gaming across the GameStop platform by testing and improving existing core assets including the store experience, knowledgeable associates and the PowerUp Rewards loyalty program. 
  • Build digital capabilities, including the recent relaunch of GameStop.com.
  •  Transform vendor and partner relationships to unlock additional high-margin revenue streams and optimize the lifetime value of every customer.

Granted, this is a cursory review, but based on what I’ve seen I am utterly unconvinced that GameStop can turn this boat around. The company faces headwinds associated with our Digital Lifestyle investing theme that are only going to grow stronger as gaming services from Apple, Microsoft and Alphabet come to market and offer the ability to game anywhere, anytime. To me, it’s very much like the slow sinking ship that was Barnes & Noble (BKS) that tried several different strategies to bail water out. 

Did GameStop have its time in the sun? Sure it did, but so did Blockbuster Video and we all know how that ended. Odds are it will be Game Over for GameStop before too long.

Getting back to Apple, now we wait for September 20 when all the new iPhone models begin shipping. Wall Street get your spreadsheets ready!

 

Elliot Management gets active in AT&T, but its prefers Verizon?

Earlier this week, we learned that activist investor Elliot Management Corp. took a position in AT&T (T). At $3.2 billion, we can safely say it is a large position. Following that investment, Elliot sent a 24-page letter telling AT&T that it needed to change to bolster its share price. Elliot’s price target for T shares? $60. I’ll come back to that in a bit. 

Soon thereafter, many media outlets from The New York Times to The Wall Street Journal ran articles covering that 24-page letter, which at one point suggested AT&T be more like Verizon (VZ) and focus on building out its 5G network and cut costs. While I agree with Elliot that those should be focus points for AT&T, and that AT&T should benefit from its spectrum holdings as well as being the provider of the federally backed FirstNet communications system for emergency responders, I disagree with its criticism of the company’s media play. 

Plain and simple, people vote with their feet for quality content. We’ve seen this at the movie box office, TV ratings, and at streaming services like Netflix (NFLX) when it debuted House of Cards or Stranger Things, and Hulu with the Handmaiden’s Tale. I’ve long since argued that AT&T has taken a page out of others’ playbook and sought to surround its mobile business with content, and yes that mobile business is increasingly the platform of choice for consuming streaming video content. By effectively forming a proprietary content moat around its business, the company can shore up its competitive position and expand its business offering rather than having its mobile service compete largely on price. And this isn’t a new strategy – we saw Comcast (CMCSA) do it rather well when it swallowed NBC Universal to take on Walt Disney and others. 

Let’s also remember that following the acquisiton of Time Warner, AT&T is poised to follow Walt Disney, Apple and others into the streaming video service market next year. Unlike Apple, AT&T’s Warner Media brings a rich and growing content library but similar to Apple, AT&T has an existing service to which it can bundle its streaming service. AT&T may be arriving later to the party than Apple and Disney, but its effort should not be underestimated, nor should the impact of that business on how investors will come to think about valuing T shares. The recent valuation shift in Disney thanks to Disney+ is a great example and odds are we will see something similar at Apple before too long with Apple Arcade and AppleTV+. These changes will help inform us as to how that AT&T re-think could play out as it comes to straddle the line between being a Digital Infrastructure and Digital Lifestyle company.

Yes Verizon may have a leg up on AT&T when it comes to the current state of its 5G network, but as we heard from specialty contractor Dycom Industries (DY), it is seeing a significant uptick in 5G related construction and its top two customers are AT& T (23% of first half 2019 revenue) followed by Verizon (22%). But when these two companies along with Sprint (S), T-Mobile USA (TMUS) and other players have their 5G network buildout competed, how will Verizon ward off subscriber poachers that are offering compelling monthly rates? 

And for what it’s worth, I’m sure Elliot Management is loving the current dividend yield had with T shares. Granted its $60 price target implies a yield more like 3.4%, but I’d be happy to get that yield if it means a 60% pop in T shares. 

 

California approves a bill that changes how contract workers are treated

California has long been a trend setter, but if you’re an investor in Uber (UBER) or Lyft (LYFT) — two companies riding our Disruptive Innovators theme — that latest bout of trend setting could become a problem. Yesterday, California lawmakers have approved Assembly Bill 5, a bill that requires companies like Uber, Lyft and DoorDash to treat contract workers as employees. 

This is one of those times that our thematic lens is being tilted a tad to focus on a regulatory change that will entitle gig workers to protections like a minimum wage and unemployment benefits, which will drive costs at the companies higher. It’s being estimated that on-demand companies like Uber and the delivery service DoorDash will see their costs rise 20%-30% when they rely on employees rather than contractors. For Uber and Lyft, that likely means pushing out their respective timetables to profitability.

We’ll have to see if other states follow California’s lead and adopt a similar change. A coalition of labor groups is pushing similar legislation in New York, and bills in Washington State and Oregon could see renewed momentum. The more states that do, the larger the profit revisions to the downside to be had. 

 

Volkswagen set to disrupt the electric vehicle market

It was recently reported that Volkswagen (VWAGY) has hit a new milestone in reducing battery costs for its electric vehicles, as it now pays less than $100 per KWh for its batteries. Given the battery pack is the most expensive part of an electric vehicle, this has been thought to be a tipping point for mass adoption of electric vehicles. 

Soon after that report, Volkswagen rolled out the final version of its first affordable long-range electric car, the ID.3, at the 2019 Frankfurt Motor Show and is expected to be available in mid-2020.  By affordable, Volkswagen means “under €30,000” (about $33,180, currently) and the ID.3 will come in three variants that offer between roughly 205 and 340 miles of range. 

By all accounts, the ID.3 will be a vehicle to watch as it is the first one being built on the company’s new modular all-electric platform that is expected to be the basis for dozens more cars and SUVs in the coming years as Volkswagen Group’s pushed hard into electric vehicles. 

Many, including myself, have been waiting for the competitive landscape in the electric vehicle market to heat up considerably – it’s no secret that all the major auto OEMs are targeting the market. Between this fall in battery cost and the price point for Volkswagen’s ID.3, it appears that the change in the landscape is finally approaching and it’s likely to bring more competitive pressures for Clean Living company and Cleaner  Living Index constituent Tesla (TSLA)

 

Weekly Issue: September Looks Like a Repeat of August

Weekly Issue: September Looks Like a Repeat of August

Key points inside this issue

  • We are establishing a buy-stop level at 9.50 for shares of Veeco Instruments (VECO), which will lock in a profit of at least 13% on this short position.
  • The Hershey Company: Tapping into Cleaner Living with M&A


We ended a volatile August… 

Stocks rebounded from some of their recent losses last week as trade tensions between the U.S. and China appear to have cooled off a bit. For the month of August in total, during which there seemed to be one market crisis after another, most of the major stock market indices finished down slightly. The outlier was the small-cap heavy Russell 2000, which shed around 5% during the month.

Looking back over the last few weeks, the market was grappling with a number of uncertainties, the most prominent of which was the announced tariff escalation in the U.S- China trade war. There were other uncertainties brewing, including the growing number of signs that outside of consumer spending, the economy continues to soften. We saw that consumer strength in Friday’s July Personal Income & Spending data, but also in the second June-quarter GDP revision that ticked down to 2.0% from 2.1%, even though estimates for consumer spending during the quarter rose to 4.7% from 4.3%. I would note that 4.7% marked the strongest level of consumer spending since the December 2014 quarter. We are, however, seeing a continued shift in where consumers are spending — moving from restaurants and department stores to quick-service restaurants and discount retailers as well as online. This raises the question as to whether the economy is prepared to meet head-on our Middle Class Squeeze investing theme?

Another issue investors grappled with as we closed out August was the yield curve inversion. While historically this does raise a red flag, it’s not a foregone conclusion that a recession is around the corner. Rather it can be several quarters away, and there are several stimulative measures that could be invoked to keep the economy growing. In other words, we should continue to mind the data and any potential monetary policy tweaking to be had.

Closing out August, more than 99% of the S&P 500 have reported earnings for the June-quarter season. EPS for that group rose just under 1%, which was far better than the contraction that was lining up just a few weeks ago. Based on corporate guidance and other factors, however, EPS expectations for both the September and December quarters have been revised lower. Some of this no doubt has to do with the next round of tariffs that took effect on Sept. 1 on Chinese imports, but we can’t dismiss the slowing speed of the global economy either.

That overall backdrop of uncertainty helps explain why the three best-performing sectors during August were Utilities, Real Estate and Consumer Staples. But as we saw in the second half of last week, a softer tone on the trade war led investors back into the market as China said it wished to resolve the trade dispute with a “calm” attitude.

Without question, investors and Corporate America are eager for forward progress on the trade war to materialize. While there have been several head fakes in recent months, we should remain optimistic. That said, we here at Tematica continue to believe the devil will be in the details when it comes to a potential trade agreement, and much like deciphering economic data, it will mean digging into that agreement to fully understand its ramifications. Those findings and their implications as well as what we hear on the monetary policy front will set the stage for what comes next. 


… and it looks like more ahead for September

This week kicks off the last month of the third quarter of 2019. For many, it will be back to work following the seasonally slow, but volatile last few weeks of summer. The question to be pondered is how volatile will September be? Historically speaking it is the worst calendar month for stocks and based on yesterday’s performance it is adhering to its reputation.

As a reminder, on Sept. 1 President Trump authorized a tariff increase to 15% from 10% on $300 billion in Chinese imports, many of which are consumer goods such as clothing, footwear and electronics.  As we saw, that line in the sand came and went over the holiday weekend and now Trump is once again rattling his trade saber, suggesting China should make a deal soon as it will only get worse if he wins the 2020 presidential election.

In addition to that, yesterday morning we received the one-two punch that was the August reading on the manufacturing economy — from both IHS Markit and the Institute of Supply Management. The revelation that manufacturing continued to slow weighed on stocks yesterday. The direction of Tuesday’s official data, however, was not a surprise to us given other data we monitor such as weekly rail car loadings, truck tonnage and the Cass Freight Index.  But as I have seen many a time, just because we are aware of something in the data doesn’t mean everyone is. 

What I suspect has rattled the market as we kick off September is the August ISM Manufacturing Survey, which showed the U.S. manufacturing sector declined to 49.1 in August. That is the lowest reading in about three years, and as a reminder, any reading below 50 signals a contraction. Data from IHS Markit also released yesterday showed the U.S. manufacturing PMI slowed to 50.3 in August, its lowest level since September 2009. Slightly better than the ISM headline print, but still down. Digging into both reports, we see new orders stalled, which suggests businesses are not only growing wary of the trade uncertainty, but that we should not expect a pickup in the month of September.

In my view, the more official data is catching up to the “other data” cited earlier and that more than likely means downward gross domestic product expectations ahead. It will also lead the market to focus increasingly on what the Fed will do and say later this month. I also think the official data is now capturing the weariness of the continued trade war. The combination of the slowing economy as well as the continued if not arguably heightened trade uncertainty will more than likely lead to restrain spending and investment in Corporate America, which will only add to the headwinds hitting the economy. 

Taking those August manufacturing reports, along with the data yet to come this week – the ISM Non-Manufacturing readings for August, and job creation data for August furnished by ADP and the Bureau of Labor Statistics — we’ll be able to zero in on the GDP taking shape in the current quarter. I would note that exiting last week, the NY Fed’s Nowcast reading for the September quarter was 1.76%, below the 2.0% second revision for June-quarter GDP. There is little question that given yesterday’s data the next adjustment to those forecasts will be lower. 

Adding to that view, we’ll also get the next iteration of the Fed’s Beige Book, which will provide anecdotal economic commentary gathered from the Fed’s member banks. And following the latest data, we can expect investors and economists alike will indeed be pouring over the next Beige Book.

No doubt, all of this global macro data and the trade war will be on the minds of central bankers ahead of their September meetings. Those dates are Sept. 12 for the European Central Bank (ECB) followed by the Fed’s next monetary policy meeting and press conference on Sept. 16-17. Given the declines in the eurozone, the ECB is widely expected to announce a stimulus package exiting that meeting, and currently the CBOE FedWatch Tool pegs a 96% chance of a rate cut by the Fed. With those consensus views in mind, should the economic data paint a stronger picture than expected it could call into question those likelihoods. If central banker expectations fail to live up to Wall Street expectations, that would more than likely give the stock market yet another case of indigestion. 

All of this data will also factor into earnings expectations. Earlier I mentioned some of the more recent revisions to the downside for the back half of 2019 but as we know this is an evolving story. That means effectively “wash, rinse, repeat” when it comes to assessing EPS growth for the S&P 500 as well as individual companies. And lest we forget, companies will not only have to contend with the effect of the current trade war and slowing economy on their businesses, but also the dollar, which as we can see in the chart below has near fresh highs for 2019. 

The biggest risk I see over the next few weeks is one of economic, monetary policy and earnings reality not matching up with expectations. Gazing forward over the next few weeks, the growing likelihood is one that points more toward additional risk in the market. We will continue to trade carefully in the near-term and heed what we gather from the latest thematic signals.


The Thematic Leaders and Select List

Over the last several weeks, the market turbulence led several positions, including those in Netflix (NFLX), Dycom (DY) and International Flavors & Fragrances (IFF) — on both the Tematica Leader board and the Select List to be stopped out. On the other hand, even though the overall markets took a bit of a nosedive during August, several of our thematic holdings, such as USA Technologies (USAT), AT&T (T), Costco Wholesale (COST), McCormick & Co. (MKC) and Applied Materials (AMAT) to name a few outperformed on both an absolute and relative basis.

Even the short position in Veeco Instruments (VECO) has returned nearly 18% since we added that to the Select List last March. That has been a particularly nice move, but also one that is playing out as expected. Currently, we have do not have a buy-stop order to protect us on our VECO position, and we are going to rectify that today. We are establishing a buy-stop level at 9.50 for shares of Veeco Instruments (VECO), which will lock in a profit of at least 13% on this short position. 

  • We are establishing a buy-stop level at 9.50 for shares of Veeco Instruments (VECO), which will lock in a profit of at least 13% on this short position.


The Hershey Company: Tapping into Cleaner Living with M&A

When we think of The Hershey Company (HSY) there is little question that its candy, gum and mints business that garnered it just over 30% of the US candy market lands its squarely in our Guilty Pleasure investing theme. Even the company itself refers to itself as the “undisputed leader in US confection” and we look at its thematic scorecard rankings, its business warrants a “5”, which means nearly all of its sales and profits are derived from our Guilty Pleasure theme. 

Not exactly a shock to even a casual observer. 

But as we’ve discussed more than a few times, consumers are shifting their preferences for food, beverages and snacks to “healthier for you” alternatives. These could be offerings made from organic or all-natural ingredients, or even ingredients that are considered to promote better health, such as protein over sugar. Recognizing this changing preference among its core constituents, Hershey hasn’t been asleep at the switch, but rather it has been making a number of nip and tuck acquisitions to improve its snacking portfolio, which aligns well with our Cleaner Living investing theme. 

These acquisitions have played out over a number of years, starting with the acquisition of the Krave jerky business (2015);  SkinnyPop parent Amplify Snacks (2017), Pirate Brands, including the Pirate’s Booty, Smart Puffs and Original Tings brands (2018). Then, just last month, Hershey acquired ONE Brands, LLC, the maker of a line of low-sugar, high-protein nutrition bars. August 2019 turned out to be a busy month for the executives of Hershey, as also in that month, the company announced minority investments in emerging snacking businesses FULFIL Holdings Limited and Blue Stripes LLC. FULFIL is a one of the leading makers of vitaminfortified, high protein nutrition bars in the UK and Ireland, while Blue Stripes offers cacao-based snacks and treats instead of chocolate ones. 

Clearly the Hershey Company is improving its position relative to our Cleaner Living investing theme. The outstanding question is to what degree are these aggregated businesses contributing to the company’s overall sales and profits? While it is safe to say Hershey has some exposure to the Cleaner Living theme, the answers to those questions will determine Hershey’s overall theme ranking. That level of detail could emerge during the company’s September quarter earnings call, but it may not until it files its 2019 10-K. 

As we wait for that October conference call, I’ll continue to do some additional work on HSY shares, including what the potential EPS impact is from not only falling sugar prices but also the pickup in cocoa prices over the last six months. In a surprise that should come to no one, given the size and influence of the company’s chocolate and confectionary business to its sales and profits, cocoa and sugar are two key inputs that can hold sway over the Hershey cost structure. 

In my mind, the long-term question with Hershey is whether it can replicate the nip and tuck transformative success Walmart (WMT) had when it used a similar strategy to reposition itself to better capture the tailwinds of our Digital Lifestyle investing theme? No doubt transformation takes time, but now is the time to see if a better business balance between our Guilty Pleasure and Cleaner Living themes emerges at Hershey.

Introducing The Thematic Leaders

Introducing The Thematic Leaders

 

Several weeks ago began the arduous task of recasting our investment themes, shrinking them down to 10 from the prior 17 in the process. This has resulted in a more streamlined and cohesive investment mosaic. As part of that recasting, we’ve also established a full complement of thematic positions, adding ones, such as Chipotle Mexican Grill (CMG) and Altria (MO) in themes that have been underrepresented on the Select List. The result is a stronghold of thematic positions with each crystalizing and embodying their respective thematic tailwinds.

This culmination of these efforts is leading us to christen those 10 new Buy or rechristened Buy positions as what are calling The Thematic Leaders:

  1. Aging of the Population – AMN Healthcare (AMN)
  2. Clean Living – Chipotle Mexican Grill (CMG)
  3. Digital Lifestyle – Netflix (NFLX)
  4. Digital Infrastructure –  Dycom Industries (DY)
  5. Disruptive Innovators – Universal Display (OLED)
  6. Guilty Pleasure – Altria (MO)
  7. Living the Life – Del Frisco’s Restaurant Group (DFRG)
  8. Middle-Class Squeeze – Costco Wholesale (COST)
  9. Rise of the New Middle-Class – Alibaba (BABA)
  10. Safety & Security – Axon Enterprises (AAXN)

 

By now you’ve probably heard me or Tematica’s Chief Macro Strategist Lenore Hawkins mention how Amazon (AMZN) is the poster child of thematic investing given that it touches on nearly all of the 10 investing themes. That’s true, and that is why we are adding Amazon to the Thematic Leaders in the 11th slot. Not quite a baker’s dozen, but 11 strong thematic positions.

One question that you’ll likely have, and it’s a logical and fare one, is what does this mean for the Select List?

We wouldn’t give up on companies like Apple (AAPL), Alphabet (GOOGL), Disney (DIS), McCormick & Co. (MKC) and several other well-positioned thematic businesses that are on the Select List. So, we are keeping both with the Thematic Leaders as the ones that offer the most compelling risk-to-reward tradeoff and the greater benefit from the thematic tailwinds. When we have to make an adjustment to the list of Thematic Leaders, a company may be moved to the Select List in a move that resembles a move to a Hold from a Buy as it is replaced with a company that offers better thematic prospects and share price appreciation. Unlike Wall Street research, however, our Hold means keeping the position in intact to capture any and all additional upside.

Another way to look at it, is if asked today, which are the best thematically positioned stocks to buy today, we’d point to the Thematic Leaders list, while the Select List includes those companies that still have strong tailwinds behind their business model but for one reason or another might not be where we’d deploy additional capital. A great example is Netflix vs. Apple, both are riding the Digital Lifestyle tailwind, but at the current share price, Netflix offers far greater upside than Apple shares, which are hovering near our $225 price target.

After Apple’s Apple Watch and iPhone event last week, which in several respects underwhelmed relative to expectations despite setting up an iPhone portfolio at various price points, odds are the iPhone upgrade cycle won’t accelerate until the one for 5G. The question is will that be in 2019 or 2020? Given that 5G networks will begin next year, odds are we only see modest 5G smartphone volumes industry-wide in 2019 with accelerating volumes in 2020. Given Apple’s history, it likely means we should expect a 5G iPhone in 2020. Between now and then there are several looming positives, including its growing Services business and the much discussed but yet to be formally announced streaming video business. I continue to suspect the latter will be subscription based.  That timing fits with our long-term investing style, and as I’ve said before, we’re patient investors so I see no need to jettison AAPL shares at this time.

The bottom line is given the upside to be had, Netflix shares are on the Thematic Leaders list, while Apple shares remain on the Select List. The incremental adoption by Apple of the organic light emitting diode display technology in two of its three new iPhone models bodes rather well for shares of Universal Display (OLED), which have a $150 price target.

Other questions…

Will we revisit companies on the Select List? Absolutely. As we are seeing with Apple’s Services business as well as moves by companies like PepsiCo (PEP) and Coca-Cola (KO) that are tapping acquisitions to ride our Clean Living investing tailwind, businesses can morph over time. In some cases, it means the addition of a thematic tailwind or two can jumpstart a company’s business, while in other cases, like with Disney’s pending launch of its own streaming service, it can lead to a makeover in how investors should value its business(es).

Will companies fall off the Select List?

Sadly, yes, it will happen from time to time. When that does happen it will be due to changes in the company’s business such that its no longer riding a thematic tailwind or other circumstances emerge that make the risk to reward tradeoff untenable. One such example was had when we removed shares of Digital Infrastructure company USA Technologies (USAT) from the Select List to the uncertainties that could arise from a Board investigation into the company’s accounting practices and missed 10-K filing date.

For the full list of both the Thematic Leaders and the Select List, click here

To recap, I see this as an evolution of what we’ve been doing that more fully reflects the power of all of our investing themes. In many ways, we’re just getting started and this is the next step…. Hang on, I think you’ll love the ride as team Tematica and I continue to bring insight through our Thematic Signals, our Cocktail Investing podcast and Lenore’s Weekly Wrap.

 

 

WEEKLY ISSUE: Scaling deeper into Dycom shares

WEEKLY ISSUE: Scaling deeper into Dycom shares

Key points from this issue:

  • We are halfway through the current quarter, and we’ve got a number of holdings on the Tematica Investing Select List that are trouncing the major market indices.
  • We are using this week’s pain to improve our long-term cost basis in Dycom Industries (DY) shares as we ratchet back our price target to $100 from $125.
  • Examining our Middle-Class Squeeze investing theme and housing.
  • A Digital Lifestyle company that we plan on avoiding as Facebook attacks its key market.

 

As the velocity of June quarter earnings reports slows, in this issue of Tematica Investing we’re going to examine how our Middle-Class Squeeze investing theme is impacting the housing market and showcase a Digital Lifestyle theme company that I think subscribers would be smart to avoid. I’m also keeping my eyes open regarding the recent concerns surrounding Turkey and the lira. Thus far, signs of contagion appear to be limited but in the coming days, I suspect we’ll have a much better sense of the situation and exposure to be had.

With today’s issue, we are halfway through the current quarter. While the major market indices are up 2%-4% so far in the quarter, by comparison, we’ve had a number of strong thematic outperformers. These include Alphabet (GOOGL), Amazon (AMZN), Apple (AAPL), AXT Inc. (AXTI), Costco Wholesale (COST),  Habit Restaurant (HABT), Walt Disney (DIS), United Parcel Service (UPS), Universal Display (OLED) and USA Technologies (USAT).  That’s an impressive roster to be sure, but there are several positions that have lagged the market quarter to date including GSV Capital (GSVC), Nokia (NOK), Netflix (NFLX), Paccar (PCAR) and Rockwell Automation (ROK). We’ve also experienced some pain with Dycom (DY) shares, which we will get to in a moment.

Last week jettisoned shares of Farmland Partners (FPI) following the company taking it’s 3Q 2018 dividend payment and shooting it behind the woodshed. We also scaled into GSVC shares following GSV’s thesis-confirming June quarter earnings report, and I’m closely watching NFLX shares with a similar strategy in mind given the double-digit drop since adding them to the Tematica Investing Select List just over a month ago.

 

Scaling into Dycom share to improve our position for the longer-term

Last week we unveiled our latest investing theme here at Tematica – Digital Infrastructure. Earlier this week, Dycom Industries (DY), our first Digital Infrastructure selection slashed its outlook for the next few quarters despite a sharp rise in its backlog. Those shared revisions are as follows:

  • For its soon to be reported quarter, the company now sees EPS of $1.05-$1.08 from its previous guidance of $1.13-$1.28 vs. $1.19 analyst consensus estimate and revenues of $799.5 million from the prior $830-$860 million vs. the $843 million consensus.
  • For its full year ending this upcoming January, Dycom now sees EPS of $2.62-$3.07 from $4.26-$5.15 vs. the $4.63 consensus estimate and revenues of $3.01-$3.11 billion from $3.23-$3.43 billion and the $3.33 billion consensus.

 

What caught my eyes was the big disparity between the modest top line cuts and the rather sharp ones to the bottom line. Dycom attributed the revenue shortfall to slower large-scale deployments at key customers and margin pressure due to the under absorption of labor and field costs – the same issues that plagued it in its April quarter. Given some of the June quarter comments from mobile infrastructure companies like Ericsson (ERIC) and Nokia (NOK), Dycom’s comments regarding customer timing is not that surprising, even though the magnitude to its bottom line is. I chalk this up to the operating leverage that is inherent in its construction services business, and that cuts both ways – great when things are ramping, and to the downside when activity is less than expected.

We also know from Ericsson and Dycom that the North American market will be the most active when it comes to 5G deployments in the coming quarters, which helps explain why Dycom’s backlog rose to $7.9 billion exiting July up from $5.9 billion at the end of April and $5.9 billion exiting the July 2017 quarter. As that backlog across Comcast, Verizon, AT&T, Windstream and others is deployed in calendar 2019, we should see a snapback in margins and EPS compared to 2018.

With that in mind, the strategy will be to turn lemons – Monday’s 24% drop in DY’s share price – into long-term lemonade. To do this, we are adding to our DY position at current levels, which should drop our blended cost basis to roughly $80 from just under $92. Not bad, but I’ll be inclined to scale further into the position to enhance that blended cost basis in the coming weeks and months on confirmation that 5G is moving from concept to physical network. Like I said in our Digital Infrastructure overview, no 5G network means no 5G services, plain and simple. As we scale into the shares and factor in the revised near-term outlook, I’m also cutting our price target on DY shares to $100 from $125.

  • We are using this week’s pain to improve our long-term cost basis in Dycom Industries (DY) shares as we ratchet back our price target to $100 from $125.

 

Now, let’s get to how our Middle-Class Squeeze investing theme is hitting the housing market, and review that Digital Lifestyle company that we’re going to steer clear of because of Facebook (FB). Here we go…

 

If not single-family homes, where are the squeezed middle-class going?

To own a home was once considered one of the cornerstones of the American dream. If we look at the year to date move in the SPDR S&P Homebuilders ETF (XHB), which is down nearly 16% this year, one might have some concerns about the tone of the housing market. Yes, there is the specter of increasing inflation that has and likely will prompt the Federal Reserve to boost interest rates, and that will inch mortgage rates further from the near record lows enjoyed just a few years ago.

Here’s the thing:

  • Higher mortgage rates will make the cost of buying a home more expensive at a time when real wage growth is not accelerating, and consumers will be facing higher priced goods as inflation winds its way through the economic system leading to higher prices. During the current earnings season, we’ve heard from a number of companies including Cinemark Holdings (CNK), Hostess Brands (TWNK), Otter Tail (OTTR), and Diodes Inc. (DIOD) that are expected to pass on rising costs to consumers in the form of price increases.
  • Consumers debt loads have already climbed higher in recent years and as interest rates rise that will get costlier to service sapping disposable income and the ability to build a mortgage down payment

 

 

And let’s keep in mind, homes prices are already the most expensive they have been in over a decade due to a combination of tight housing supply and rising raw material costs. According to the National Association of Home Builders, higher wood costs have added almost $9,000 to the price of the average new single-family since January 2017.

 

 

Already new home sales have been significantly lower than over a decade ago, and as these forces come together it likely means the recent slowdown in new home sales that has emerged in 2018 is likely to get worse.

 

Yet our population continues to grow, and new households are being formed.

 

This prompts the question as to where are these new households living and where are they likely to in the coming quarters as homeownership costs are likely to rise further?

The answer is rental properties, including apartments, which are enjoying low vacancy rates and a positive slope in the consumer price index paid of rent paid for a primary residence.

 

There are several real estate investment trusts (REITs) that focus on the apartment and rental market including Preferred Apartment Communities, Inc. (APTS) and Independence Realty Trust (IRT). I’ll be looking at these and others to determine potential upside to be had in the coming quarters, which includes looking at their attractive dividend yields to ensure the underlying dividend stream is sustainable. More on this to come.

 

A Digital Lifestyle company that we plan on avoiding as Facebook attacks its key market

As important as it is to find well-positioned companies that are poised to ride prevailing thematic tailwinds that will drive revenue and profits as well as the share price higher, it’s also important to sidestep those that are running headlong into pronounced headwinds. These headwinds can take several forms, but one of the more common ones of late is the expanding footprint of companies like Alphabet (GOOGL), Amazon (AMZN) and Facebook (FB) among others.

We’ve seen the impact on shares of Blue Apron (APRN) fall apart over the last year following the entrance of Kroger (KR) into the meal kit business with its acquisition of Home Chef and investor concerns over Amazon entering the space following its acquisition of Whole Foods Market. That changing landscape highlighted one of the major flaws in Blue Apron’s subscription-based business model –  very high customer acquisition costs and high customer churn rates. While we warned investors to avoid APRN shares back last October when they were trading at north of $5, those who didn’t heed our advice are now enjoying APRN shares below $2.20. Ouch!

Now let’s take a look at the shares of Meet Group (MEET), which have been on a tear lately rising to $4.20 from just under $3 coming into 2018. The question to answer is this more like a Blue Apron or more like USA Technologies (USAT) or Habit Restaurant (HABT). In other words, one that is headed for destination @#$%^& or a bona fide opportunity.

According to its description, Meet offers  applications designed to meet the “universal need for human connection” and keep its users “entertained and engaged, and originate untold numbers of casual chats, friendships, dates, and marriages.” That sound you heard was the collective eye-rolling across Team Tematica. If you’re thinking this sounds similar to online and mobile dating sites like Tinder, Match, PlentyOfFish, Meetic, OkCupid, OurTime, and Pairs that are all part of Match Group (MTCH) and eHarmony, we here at Tematica are inclined to agree. And yes, dating has clearly moved into the digital age and that falls under the purview of our Digital Lifestyle investing theme.

Right off the bat, the fact that Meet’s expected EPS in 2018 and 2019 are slated to come in below the $0.39 per share Meet earned in 2017 despite consensus revenue expectations of $181 in 2019 vs. just under $124 million in 2017 is a red flag. So too is the lack of positive cash flow and fall off in cash on the balance sheet from $74.5 million exiting March 2017 to less than $21 million at the close of the June 2018 quarter. A sizable chunk of that cash was used to buy Lovoo, a popular dating app in Europe as well as develop the ability to monetize live video on several of its apps.

Then there is the decline in the company’s average total daily active users to 4.75 million in the June 2018 quarter from 4.95 million exiting 2017. Looking at average mobile daily active users as well as average monthly active user metrics we see the same downward trend over the last two quarters. Not good, not good at all.

And then there is Facebook, which at its 2018 F8 developer conference in early May, shared it was internally testing its dating product with employees. While it’s true the social media giant is contending with privacy concerns, CEO Mark Zuckerberg shared the company will continue to build new features and applications and this one was focused on building real, long-term relationships — not just for hookups…” Clearly a swipe at Match Group’s Tinder.

Given the size of Facebook’s global reach – 1.47 billion daily active users and 2.23 billion monthly active users – it has the scope and scale to be a force in digital dating even with modest user adoption. While Meet is enjoying the monetization benefits of its live video offering, Facebook has had voice and video calling as well as other chat capabilities that could spur adoption and converts from Meet’s platforms.

As I see it, Meet Group have enjoyed a nice run thus far in 2018, but as Facebook gears into the digital dating and moves from internal beta to open to the public, Meet will likely see further declines in user metrics. So, go user metrics to go advertising revenue and that means the best days for MEET shares could be in the rearview mirror. To me this makes MEET shares look more like those from Blue Apron than Habit or USA Technologies. In other words, I plan on steering clear of MEET shares and so should you.

 

 

As earnings move into the fast lane, things are likely to get bumpier

As earnings move into the fast lane, things are likely to get bumpier

Key Points from this Alert

  • With market volatility picking up as earnings velocity takes off, we are keeping our inverse ETF position intact.
  • Recent data confirms our short bias on General Motors (GM) and Simon Property Group (SPG).
  • Today we are using a lackluster developer conference to scale into Facebook (FB) May 2017 $150 calls (FB170519C00150000) as we drop our stop loss to $0.75 from $1.00.

Over the last two weeks, we’ve seen the stock market bounce up and down with both oil and gold prices doing the same. The latest blow in oil prices comes following a report on Tuesday that “U.S. crude stockpiles fell less than expected in the latest week while gasoline stockpiles grew unseasonably” — not exactly something we want to hear as economists and others trim back their GDP forecasts.

Peering below the headlines, we saw the first dip in the manufacturing component of the monthly Industrial Production report in March. Even if we exclude the step-down in the production of motor vehicles and parts, March manufacturing output still declined. Furthermore, revisions to January and February meant manufacturing activity was weaker than previously thought.

Yes, we realize that we have been talking about this for several weeks, and while we take solace in knowing that once again the herd is catching up to us, we’re not exactly thrilled the latest data suggests there is more revising to be done. As this is happening, we are also seeing a drop in Fed interest rate hike expectations. Just a few weeks ago, 57 percent of traders expected the Fed to boost interest rates two more times this year. As of last night, that expectation fell to 36 percent according to CME Group’s FedWatch program.

Tracing back the market’s up and downs over the past month or so tells us investors continue to look for some direction, and in our view, the coming days are likely to offer the road map. The issue is, the road ahead may not be the one that most are hoping to take and its guide will be the plethora of earnings reports we get not just this week, but increasing pace over the next two weeks. Compared to some 300 reports this week — the vast majority of which will hit after tonight’s market close — next week has more than 990 companies reporting followed by another 1,269 during the first week of May.

As this pace picks up, we’re seeing more political drama unfold in Washington, and when we put it all together it tells us there is more risk to be had in the near-term than reward. While we recognize we are likely preaching to the choir at this point, the simple truth is corporate expectations needs to be reset given the economic climate and as that happens we are likely to see more wind taken out of the stock market’s sales.

 


In looking at the recent move in the Volatility Index (VIX), which recently hit its highest level since before the November election, the market is on edge as earnings ramp up. Adding to this is some new findings from the Bank of America Merrill Lynch monthly fund manager survey that shows some 83 percent of fund managers believe U.S. stocks are overvalued. As always we try to put data like this into perspective, and in doing so we find that 83 percent is a record number for data that reach back to 1999.

Now that certainly tells several things, but the one we are zeroing in on is the simple fact that in a nervous market, investors are likely to shoot first and ask questions later when faced with a barrage of earnings reports.

  • For these reasons, we will continue to stick with all of our inverse stock market ETFs — the ProShares Short S&P500 (SH), ProShares Short Russell 2000 (RWM) and ProShares Short Dow30 (DOG), all of which climbed higher over the last two weeks — for at least the next several weeks. 

 


 

Turning to Our Short Positions in
General Motors (GM) and Simon Property Group (SPG)

The March Retail Sales report confirmed our concern over the consumer’s ability and willingness to spend. The fact that 1Q 2017 was the worst quarter for restaurant traffic in three years is yet another confirming sign of that fact. As earnings reports roll in, we’ll take stock in what Visa (V) and MasterCard (MA)have to say about consumer spending, but with more than $1 trillion in consumer credit card debt, we are inclined to keep our short position in GM and SPG shares intact.

  • We continue to have a Sell rating on GM shares with a price target of $30. 
  • Our buy stop order on GM remains at $40. As the shares continue to move lower, we’ll look to revisit our buy-stop loss further with a goal of using it to lock in position profits.
  • With retail pain likely to intensify, we continue to have a bearish view on SPG shares. Our price target on SPG remains $150 and our buy stop order remains at $190.
  • As SPG shares move lower, we’ll continue to ratchet down this buy stop order as well. 

 


 

That Brings Us to Our One Long Position — Facebook

The Facebook (FB) May 2017 $150 calls (FB170519C00150000), closed last night at $1.10, modestly above our $1.00 stop loss level. The calls have traded off over the last two days and we can understand why. We have to say we were somewhat underwhelmed by this year’s annual developer conference, better known as F8, that spanned the last two days. CEO Mark Zuckerberg has announced a series of new features covering augmented reality, artificial intelligence bots, and more far-fetched plans to close the gap between humans and machines. In particular, Zuckerberg wants Facebook users to be able to “type with their brains and hear with their skin.”

If you thought you heard our eyes roll, you were correct.

Each of these announced initiatives will take Facebook time to develop and then, in turn, it will be even more time for them to have a meaningful impact on the company’s business model — far more time than we have with our May calls.

That said, given Alphabet’s (GOOGL) recent snafu with YouTube and advertisers, we suspect Facebook saw a bump in advertising that should help it keep its earnings beating track record intact. With the company set to report its 1Q 2017 earnings on May 3, we’ll use the recent pullback in the calls to scale into the position, reducing our cost basis along the way. As we do this, we will drop our protective stop loss to $0.75 as well.

The Data Says Steady as She Goes

The Data Says Steady as She Goes

Key Points from this Alert

  • With market volatility expected to pick up as we head into earnings, we’re keeping our inverse ETF positions in tact.
  • March auto sales data, as well as the growing concern over the consumer, have us keeping our short positions on both General Motors (GM) and Simon Property Group (SPG) shares.
  • While the Facebook (FB) May 2017 $150 calls (FB170519C00150000) calls dipped week over week, the two major catalysts behind the trade remain ahead of us. We continue to rate the calls a Buy.

We’re slowing inching our way closer toward 1Q 2017 earnings season, which, as we shared earlier this week, we think could bring a return of volatility to the stock market. We’ve read a lot of bullish commentary, with many pointing to the robust inflow of funds into ETFs during 1Q 2017 — $134.7 billion vs. 29.6 billion in inflows in 1Q 2016 – but we have to remember individual investors tend to stay on sidelines only to return to the market near the top.

Part of what’s to blame is the overly bullish talking heads, and in my readings, I found a great example of this. Financial firm LPL published the following commentary about 1Q 2017:

Although the S&P 500 Index just missed out on a five-month winning streak in March with a 0.04% loss, the good news is it still gained 5.5% in the first quarter.|

“This came out to the best quarter overall since the fourth quarter of 2015, and it was the best first quarter gain since 2013! Going back to 1950, this was the 25th time the S&P 500 gained 5% or more during the first quarter. The good news for the bulls is the returns after a big first quarter have been broadly stronger across the board.”

Now let’s dig into this…. there have been 67 years between 1950 and 2017, and doing some basic math we find 25/67 equals 37 percent. This means the “good news” for the bulls happens a little more than one-third the time. This also means that nearly two-thirds of the time, it doesn’t happen.

Just another example that we need to really dig into the data with context and perspective to understand what is really going on vs. what is being said. In doing so with this LPL commentary, we’ll be generous and say it has an overly bullish slant given the data. With the herd taking a bullish view despite the hard data we’ve been getting that calls for a rest in expectations for both 2017 earnings and GDP forecasts, we’ll continue to keep all three of our inverse ETFs in the Pro Select List.


Housekeeping!

Before we get to recapping our existing positions, we have a quick housekeeping reminder. As we mentioned in yesterday’s Tematica Investing, we’ll be using the market holiday next week to take a breather to get ready for the explosion in earnings reports that will begin the day after Easter. As such, your next regular issue of Tematica Pro will be April 20.

Rest assured that is something important comes along, we’ll be sure to issue a special alert.

 


March Auto Sales Confirm our Bearish View on GM 

March was supposed to be the month US auto sales rebounded from decreases in January and February. Instead, ample discounts were unable to spur demand for at the biggest automakers such as Ford (F), Fiat, and Toyota (TMC), and Honda (HMC), which all posted year over year declines. Sales incentives rose 13.4 percent in March, compared to a year earlier, to an average of $3,511 per vehicle, according to ALG. Making matters even worse, production is outpacing sales, which means auto dealers getting stuck with too many vehicles. Inventory levels hit 4.1 million units entering the month, the highest level since June 2004, according to Edmunds analysis based on Ward’s Auto figures.

General Motors faired a little better, with its US sales rising 2 percent year over year in March, but that was well below the consensus forecast that called for a +9.6 percent increase year over year.

As we look around us and see consumers saving more while others are grappling with rising bank card and subprime auto loan delinquencies, we continue to question the degree of new car demand. Adding to our concern is a new report from the Mortgage Bankers Association that showed the average size of a home loan was the largest in the history of its survey, which dates back to 1990. Another data point that points to Cash-strapped Consumers at a time when auto loan costs are ticking higher following the Fed’s two recent interest rate hikes.

GM will report its 1Q 2017 earnings on Friday, April 28 and as important as the rear view mirror quarterly results are, it will be the guidance that sets the tone for GM shares in 2Q 2017.

  • We continue to have a Sell rating on GM shares with a price target of $30. 
  • Our buy stop order on GM remains at $40. As the shares continue to move lower, we’ll look to revisit our buy-stop loss further with a goal of using it to lock in position profits. 

 


More Retail Pain Adds to Bearish Resolve on Simon Properties 

Next week will bring the March Retail Sales report, and based on what we’ve heard from retailers over the last few weeks paired with the data we’ve been sharing of late that shows our Cash-Strapped Consumer theme remains in full force, odds are it won’t be a pretty report. With Payless (PSS) and Bebe (BEBE) filing for bankruptcy and hhgregg (HGG) likely headed for liquidation, these are just the latest retailers that are dying on the vine. As we have learned this week, others are wounded including Urban Outfitters (URBN), shared its quarter to date sales are down in the mid-single digits, and Saks owner Hudson Bay (TSE:HBC) reported a drop in overall consolidated sales.

While Simon Property Group (SPG) rose modestly over the last week, we continue to be concerned over the shrinking customer landscape. We are also mindful that we will soon begin to see store closings from anchor tenants like Macy’s (M), JC Penney (JCP) and others. As those closings progress, we suspect investor sentiment will weigh on SPG shares.

  • With retail pain likely to intensify, we continue to have a bearish view on SPG shares. Our price target on SPG remains $150 and our buy stop order remains at $190.
  • As SPG shares move lower, we’ll continue to ratchet down this buy stop order as well.

 


Facebook continues to expand its footprint;
All eyes on April 18-19

Shares of this Connected Society investment theme social media company that is morphing into much more dipped modestly over the last several days, which reflected a similar move in the Nasdaq Composite Index. While Facebook lost out on its bid to stream the NFL’s Thursday Night Football package, we continue to see it benefitting from YouTube’s recent advertising snafu as branded companies ranging from AT&T (T) to Johnson & Johnson (JNJ) pull advertising spend.

That’s a nice development for FB shares as well as our Facebook (FB) May 2017 $150 calls (FB170519C00150000) calls, but we still have the two major factors ahead of us that led to our adding the call position to the select list. First, on April 18-19 is Facebook’s annual F8 Developer Conference at which we expect a number of updates and announcements from new monetization strategies to its plans for virtual as well as augmented reality and now payments.

That’s right, we said payments. Through its WhatsApp business, Facebook is launching digital payments in India, which happens to be WhatsApp’s largest market with more than 200 million users. Given the November 2017 ban on high-value currency notes in India as well as the country’s push into digital payments, we see WhatsApp as extremely well positioned for this. Forecasts have mobile payments growing to $2.57 billion in India by 2021, up from just $79 million this year, which would be awesome if it happened. Even if it falls short of that target, there is still phenomenal growth ahead that bodes well for our Facebook shares as well as the Facebook (FB) May 2017 $150 calls (FB170519C00150000) calls.

The second date to watch will be Facebook’s 1Q 2017 quarterly earnings that will be reported on May 3. Given its focus on monetization and mobile, Facebook has been handily beating expectations, and given the growing adoption of its platforms across the globe we see the company continuing that trend once again.

Adding more protection, but also taking advantage of YouTube’s misfortune

Adding more protection, but also taking advantage of YouTube’s misfortune

Key Points from this Alert

  • We are adding ProShares Short Dow30 (DOG) shares to the Select List with a price target of $$20, and should the shares trade below their 52-week low of $17.69 in the next several days we’re likely to scale into the position.
  • We are also adding the Facebook (FB) May 2017 $150 calls (FB170519C00150000) that closed last night at 1.85 to the select list. As we do that we’ll set a protective stop loss at 1.00. We’d be buyers of the calls up to the $2.25 level.
  • We continue to have a negative bias on both General Motors (GM) as well as Simon Property Group (SPG) shares. 

With all of two days left in the month of March and 1Q 2017, it certainly looks like March has been a sobering month for the S&P 500 and Dow Jones Industrial Average as both indices have shed gains over the last few weeks. We tend not to pat ourselves on the back as we recognize that self-serving comments can be a little cheesy, but in this case, the concerns we laid out in February came home to roost in March. As we shared yesterday, the disconnect between stock prices, economic growth and earnings expectations remains and we think it’s going to be a very bumpy earnings season in just a few weeks.

 

As investors have come around to our view, we’ve seen a radical change in the CNN Money Fear & Greed Index, which closed last night at 34 (Fear) from 70 (Greed) just 30 days ago. Even though the Volatility Index has traded off the last few days, as you can see in the chart below it’s not too far off year to date lows.

 

Given the above, we’re going to hang on to our ProShares Short S&P500 (SH) and ProShares Short Russell 2000 (RWM) shares and add ProShares Short Dow30 (DOG) shares to the mix. DOG shares are an inverse ETF for the Dow Jones Industrial Average, and are coming off their 52-week low given the strong move in the Dow over the last several months. As we saw in recent earnings reports from Nike (NKE), Target (TGT), FedEx (FDX), and last night LuluLemon (LULU), if this is what we’re in for it makes sense to add another layer of protection to the Select List.

  • We are adding ProShares Short Dow30 (DOG) to the Tematica Pro Select List.
  • Our price target on DOG shares is $20, and should the shares trade below their 52-week lows of $17.69 in the next several days we’re likely to scale into the position.

 

 

Getting back into Facebook calls

As we wrote yesterday in Tematica Investing, we see Facebook (FB) as a natural beneficiary of Alphabet’s (GOOGL) current bout of problems that centers on questionable YouTube content that has led to advertisers ranging from AT&T (T) and Verizon (VZ) to Volkswagen, Honda (HMC) and McDondald’s (MCD) to pull their ads from YouTube. Estimates put the potential revenue loss between $750 million to $1.25 billion, but we don’t think we’ll have a clear sense of the magnitude until we see how long those companies hold back their advertising spend with YouTube.

With several platforms at Facebook, including Facebook, Instagram and Messenger, that it continues to add increased functionality and monetization efforts, we see it as the natural beneficiary. This is especially the case given continued struggles at Twitter and Facebook adding features at Instagram that take aim at Snapchat (SNAP). As a reminder, Facebook continues to target live sporting events and other streaming capabilities, which could lead it to pick off TV advertising dollars. Finally, in a few weeks, Facebook will be holding its annual developer conference dubbed F8, which tends to be a showcase for new initiatives. Soon after the company will report its quarterly earnings and that has us eyeing the Facebook (FB) May 2017 $150 calls (FB170519C00150000) that closed last night at 1.85.

  • We’re adding those Facebook (FB) May 2017 $150 calls (FB170519C00150000) calls to the Select Listand as we do that we’ll set a protective stop loss at 1.00. We’d be buyers of the calls up to the $2.25 level.
  • As we do that we’ll set a protective stop loss at 1.00. We’d be buyers of the calls up to the $2.25 level.
  • We’d be buyers of the calls up to the $2.25 level.

 

 

Still bearish on General Motors and Simon Property Group shares

While both General Motors (GM) and Simon Property Group (SPG) shares traded modestly higher over the last few days, we continue to be bearish on both. The latest data show auto incentives have soared, particularly at General Motors, which is likely to eat into profits. With Americans missing bank cards payments at the highest levels since July 2013, the delinquency rate for subprime auto loans hitting the highest level in at least seven years and real wage growth remaining elusive, the outlook for consumer spending looks questionable. This includes auto sales as well as brick & mortar retailers.

We’ve written about issues at a number of such retailers, but we continue to hear about more being in trouble. The latest additions include Gymboree, Claire’s Stores, Ascena (ASNA), and Bebe Store (BEBE). Factor in the yet to be felt pain of store closing from Macy’s (M), Sears (SHLD) and J.C. Penney (JCP), and we continue to see more downside than upside with SPG shares.

  • We’ll continue to keep our short position in General Motors (GM), with a price target of $30. 
  • Our buy stop order on GM remains at $40. As the shares continue to move lower, we’ll look to revisit our buy-stop loss further with a goal of using it to lock in position profits. 
  • With retail pain likely to intensify, we continue to have a bearish view on SPG shares. Our price target on SPG remains $150 and our buy stop order remains at $190.
  • As SPG shares move lower, we’ll continue to ratchet down this buy stop order as well. 

 

As the market mood turns sour, we continue to favor our short positions

As the market mood turns sour, we continue to favor our short positions

Key Points from this Alert

  • With investors questioning the moves that have led the market higher over the last few months and revisiting earnings expectations for the S&P 500, we are counting our losses and exiting the United Parcel Service (UPS) April 2017 $110 calls (UPS170421C00110000) on the Tematica Select List.
  • More data points this week have added to our bearish view on General Motors (GM) shares, which have already fallen more than 7 percent since being added to the Select List. 
  • Similarly, investment firms turning increasingly negative on retail and a warning in Sears’s 10-K filing have us even more confident in the Simon Property Group (SPG) short position on the Select List.
  • With the market looking to get bumpy, our inverse ETF positions that are on the Select List are coming into favor as planned.

As we shared in yesterday’s Tematica Investing, spring has brought a shifting wind into the marketplace that has brought investor mindsets more in tune with what we’ve been saying over the last few months. We’ve also gotten a number of warnings signs over earnings growth, and more confirmation that retailer pain is only getting worse. That’s rather good news for the Simon Property Group (SPG) short position on the Select List.

With the prospects of further earnings revisions to be had in the coming weeks, which in our view will likely pressure markets further, we’ll be holding off adding any new call positions near term as we continue to examine potential short positions like General Motors (GM) and Simon Property Group (SPG). We’ll also be eying potential put positions as well. It also means that we’ll keep our inverse ETF positions intact as well; subscribers that have held off in adding these should revise those at current levels.

Before review our existing positions, a quick housekeeping item. The shifting market mindset that led to the worst day in the market for several weeks this past Tuesday stopped our the PowerShares DB US Dollar Bullish ETF (UUP) June 2017 $27 calls (UUP170616C00027000) on the Select List.

 

Shedding UPS calls?

Our UPS April 2017 $110 calls (UPS170421C00110000) calls have been all over the map the last few days due primarily to the market movement. While we continue to see UPS’s business as the missing link for the accelerating shift to digital commerce that is part of our Connected Society investing theme, given prospects for the market to get even bumpier in the days ahead, we’re going to cut our losses and exit the position with a 55 percent loss. While tempting to scale into the position, the fact that earnings expectations for the S&P 500 are likely to come down in the coming weeks means we’d be fighting the tide on this one.

 

Still bearish on General Motors shares

Last week we added a short position on General Motors (GM) shares given rising concerns over consumer debt levels and a pick up in auto subprime loan defaults as the Fed inched up interest rates. Yesterday we were reminded of this when Fitch Rating published its new U.S. Auto Asset Quality Review report that showed its view that auto loan and lease credit performance will continue to deteriorate in 2017. The report goes on to note that in response to deteriorating asset quality banks are starting to tighten underwriting standards once again, which could either lead to fewer auto loans, which would be bad for auto sales, or the financing arms of car companies, like General Motors, taking on more speculative loans — not exactly a good thing for the company balance sheet given the data we are seeing.

Making matters a little worse, we’re seeing a glut of used cars come onto the market. That trend will intensify as Americans will return 3.36 million leased cars and trucks this year, another jump after a 33 percent surge in 2016, according to J.D. Power.

That combination led financing company Ally Financial (ALLY) to slash its 2017 earnings forecast earlier this week. Back in January, the company expected to deliver EPS growth near 15 percent this year. Now the company sees its earnings rising as little as 5 percent this year.

  • Against that backdrop, we’ll continue to keep our short position in General Motors (GM), with a price target of $30. 
  • The shares have already fallen more than 7 percent in the last week, which has us moving our buy stop order down to $40 from $42. 
  • As the shares continue to move lower, we’ll look to revisit our buy-stop loss further with a goal of using it to lock in position profits. 

 

Sears and Payless spell more pain for Simon Property Group

Thus far our short position in Simon Property Group (SPG) has returned more than 9 percent over the last few weeks. Over the last few days, a few new data points bolstered our confidence in the underlying thesis for this short position. First, Wells Fargo has turned bearish on retailer noting that, ““increasingly clear that retail is under significant pressure” adding that store traffic remains weak and is likely to get softer this quarter due to the timing of Easter this year. Worse yet, markdown rates are not only elevated on an annual basis, but also getting sequentially worse. Those remarks were followed by investment firm Cowen sharing its latest retail channel checks for March that came in worse than expected. Clearly more pressure ahead for brick & mortar retailers.

The real blow for SPG shares came in Sears’s (SHLD) 10-K filing in which the company said, “substantial doubt exists related to the company’s ability to continue as a going concern.” We’ve long known that Shield was a company struggling to identify what it was as our Connected Society investment theme has transformed where and how people shop. The issue for Simon Property Group is Sears is a key anchor tenant across a number of its properties. Paired with other store closings from Macy’s (M), JC Penney (JCP) and a growing list of others, we see more pressure ahead on SPG’s business model. By the way, this is a great reminder as to how useful company filings, like 10-Ks and 10-Qs, can be.

That pressure now includes prospects per Bloomberg that Payless (PSS) is likely to file for bankruptcy next week. As you’ll hear us talk on our Cocktail Investing Podcast coming out later today, given inroads by Amazon (AMZN) and Zappos in the shoe market, we’re somewhat surprised that Payless has lasted this long.

  • With retail pain likely to intensify, we continue to have a bearish view on SPG shares. Our price target remains $150. 
  • With shares moving lower in recent weeks, we are adjusting our buy stop order to $190 from $200. 
  • As the shares move lower, we’ll continue to ratchet down this buy stop order as well. 

 

Walking a Tight Rope as the Fed Faces a Stagflating Economy

Walking a Tight Rope as the Fed Faces a Stagflating Economy

The big question that’s been overhanging the market this week was cleared up yesterday when the Fed announced the next upward move in interest rates, something the stock market has been increasingly expecting over the last several weeks. In looking at the Fed’s new forecasts compared to those issued three months ago, there were no material changes in the outlook for GDP, the Unemployment Rate, on expected inflation.

We find the Fed’s action yesterday rather interesting against that backdrop, especially given its somewhat lousy track record when it comes to timing its rate increases —  more often than not, the Fed tends to raise interest rates at the wrong time. This time around, however, it seems the Fed is somewhat hellbent on getting interest rates back to normalized levels from the artificially low levels they’ve been at for nearly a decade. Even the language with which they announced the rate hike — “In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 3/4 to 1 percent” — makes one wonder exactly what data set they are using to base the decision.

The thing is, recent economic data hasn’t been all that robust. Yesterday morning, the Fed’s own Atlanta Fed once again slashed its GDPNow forecast for 1Q 2016 yesterday to 0.9 percent from 1.2 percent last week and more than 3.0 percent in January. That’s a big downtick from 1.9 percent GDP in 4Q 2016! Given the impact of winter storm Stella, particularly in the Northeast corridor, odds are GDP expectations will once again tick lower as consumer spending and brick & mortar retail sales were both disrupted. As Tematica’s Chief Macro Strategist Lenore Hawkins pointed out yesterday, real average hourly earnings decreased 0.3 percent, seasonally adjusted, year over year in February.

Despite that lack of wage growth, we have seen inflation pick up over the last several months inside the Purchasing Managers’ Indices published by Markit Economics and ISM for both the manufacturing and services economies as well as the Producer Price Index. Year over year in February, the Producer Price Index hit 2.2 percent, marking the largest 12-month increase since March 2012. Turning to the Consumer Price Index, the headline figure rose 2.7 percent this past February compared to a year ago, making it the 15th consecutive month the 12-month change for core CPI was between 2.1 percent and 2.3 percent. We’ve all witnessed the rise in gas prices, up some 18 percent compared to this time last year, and while there are adjustments to strip out food and energy from these inflation metrics, our view at Tematica is food and energy are costs that both businesses and individuals must bear. Rises prices for those items impact one’s ability to spend, especially if wages are not growing in tandem.

It would seem the Fed is caught once again between a rock and a hard place — the economy is slowing and inflation appears to be on the move. The economic term for such an environment is stagflation. In looking to get a handle on stagflation the Fed is walking a thin line between trying to get a handle on inflation while not throwing cold water on the economy as it continues to target two more rate hikes this year.

Once again, we find ourselves rather relieved that we don’t have Fed Chairwoman Janet Yellen’s job. We’re far more content to look at the intersecting and shifting landscapes around us to look for companies positioned to prosper from multi-year thematic tailwinds like those found on the Tematica Select List. Great examples include Buy rated Applied Materials (AMAT), Dycom Industries and Universal Display (OLED) among others. As we do this, we recognize the stock market is out over its ski tips and yet to fully bake in the current and likely near-term economic reality into its thinking especially as the likely timing on potential Trump economic policies look further out than previously thought. This is likely to offer the opportunity to find such thematic beneficiaries at better prices in the coming weeks compared to today.

While we may be a tad ahead of the herd on this, we’ll continue to be prudent investors and let the data, the hard data, talk to us as we navigate our next moves with the Tematica Select List.

The Fed Hikes Rates, But We’re Positioning for the Coming Fallout

The Fed Hikes Rates, But We’re Positioning for the Coming Fallout

Key Points from this Alert

The big question that’s been overhanging the market this week was cleared up yesterday when the Fed announced the next upward move in interest rates, something the stock market has been increasingly expecting over the last several weeks. In looking at the Fed’s new forecasts compared to those issued three months ago, there were no material changes in the outlook for GDP, the Unemployment Rate, or expected inflation.

We find the Fed’s action yesterday rather interesting against that backdrop, especially given its somewhat lousy track record when it comes to timing its rate increases —  more often than not, the Fed tends to raise interest rates at the wrong time. This time around, however, it seems the Fed is somewhat hellbent on getting interest rates back to normalized levels from the artificially low levels they’ve been at for nearly a decade. Even the language with which they announced the rate hike — “In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 3/4 to 1 percent” — makes one wonder exactly what data set they are using to base the decision.

The thing is, recent economic data hasn’t been all that robust. Yesterday morning, the Fed’s own Atlanta Fed once again slashed its GDPNow forecast for 1Q 2016 yesterday to 0.9 percent from 1.2 percent last week and more than 3.0 percent in January. That’s a big downtick from 1.9 percent GDP in 4Q 2016. Given the impact of winter storm Stella, particularly in the Northeast corridor, odds are GDP expectations will once again tick lower as consumer spending and brick & mortar retail sales were both disrupted. As Tematica’s Chief Macro Strategist Lenore Hawkins pointed out yesterday, real average hourly earnings decreased 0.3 percent, seasonally adjusted, year over year in February.

Despite that lack of wage growth, we have seen inflation pick up over the last several months inside the Purchasing Managers’ Indices published by Markit Economics and ISM for both the manufacturing and services economies as well as the Producer Price Index. Year over year in February, the Producer Price Index hit 2.2 percent, marking the largest 12-month increase since March 2012.

Turning to the Consumer Price Index, the headline figure rose 2.7 percent this past February compared to a year ago, making it the 15th consecutive month the 12-month change for core CPI was between 2.1 percent and 2.3 percent. We’ve all witnessed the rise in gas prices, up some 18 percent compared to this time last year, and while there are adjustments to strip out food and energy from these inflation metrics, the reality is food and energy are costs that both businesses and individuals must bear. Rising prices for those items impact the consumers’ ability to spend, especially if wages are not growing in tandem, and they also eat into the margins for a business — spending more money to light and heat facilities and gas up vehicles.

It would seem the Fed is caught once again between a rock and a hard place — the economy is slowing and inflation appears to be on the move. The economic term for such an environment is stagflation. In looking to get a handle on stagflation the Fed is walking a thin line between trying to get a handle on inflation, while not throwing cold water on the economy as it continues to target two more rate hikes this year.

Once again, we find ourselves rather relieved that we don’t have Fed Chairwoman Janet Yellen’s job. The renewed “commitment” by the Fed bodes well for interest rate sensitive companies such as banks like Wells Fargo (WFC), Citigroup (C) and Bank of America to name a handful, as well as Financial Select Sector SPDR Fund (XLF) shares.

 

Car Loan Pain Point Data Brings Us to Our Key Move for the Day

While higher interest rates might be a positive for financials, at the margin, however, it comes at a time when credit card debt levels are approaching 2007 levels as are adjusted rate mortgages and auto loans, particularly subprime auto loans. Even before the rate increase, data published by S&P Global Ratings shows US subprime auto lenders are losing money on car loans at the highest rate since the aftermath of the 2008 financial crisis as more borrowers fall behind on payments.

In 4Q 2016, the rate of car loan delinquencies rose to its highest level since 4Q 2009, according to credit analysis firm TransUnion (TRU). The auto delinquency rate — or the rate of car buyers who were unable make loan payments on time — rose 13.4 percent year over year to 1.44 percent in 4Q 2016 per TransUnion’s latest Industry Insights Report. That compares to 1.59 percent during the last three months of 2009 when the domestic economy was still feeling the hurt from the recession and financial crisis. And then in January, we saw auto sales from General Motors (GM), Ford (F) and Fiat Chrysler (FCAU) fall despite leaning substantially on incentives.

Over the last six months, shares of General Motors, Ford and Fiat Chrysler are up 19 percent, 4.5 percent and more than 70 percent, respectively. A rebound in European car sales, as well as share gains, help explain the strong rise in FCAU shares, but the latest data out this morning shows European auto sales growth cooled in February.

So what’s an investor in these auto shares to do, especially if you added GM or FCAU shares in early 2016? Do the prudent thing and take some profits and use the proceeds to invest in companies that are benefitting from multi-year tailwinds such as Applied Materials (AMAT), Dycom Industries (DY) or Universal Display (OLED) like we have on the Tematica Select List.

For more aggressive investors, like those of us here at Tematica Pro, we’re adding shares to General Motors (GM), which are currently trading at 6.1x 2017 earnings that are forecasted to fall to $6.02 per share from $6.12 per share in 2016, with a Sell rating and instilling a short position on the Tematica Pro Investment List.

While some may see that low P/E ratio, we’d point out that GM shares are trading near their 52-week high and peaked at 6.2x 2016 earnings and bottomed out at 4.6x 2016 earnings last year. Despite the soft economic data that shows enthusiasm and optimism for the economy, the harder data suggests we are more likely to see GM’s earnings expectations deteriorate further. And yes, winter storm Stella likely did a number of auto sales in March.

  • We are adding GM shares to the Tematica Pro Investment List with a Sell rating and a short position.
  • Our price target is $30, which offers a return of 19 percent from last night’s market closing price of $37.09. 
  • Because this is a short position we will be setting a protective buy stop order to limit potential capital losses in this position at $42
Closing out Trinity Calls

Given the data that points to a slowing economy this quarter, we are going to throw in the towel on the call position in Trinity Industries — the Trinity Industries (TRN) April 2017 $30 calls (TRN170421C00030000) this morning. Even though railcar traffic has been improving, the overall economic tone of the near-term is likely to be a headwind to new railcar orders and we think it’s best to cut our losses now at a 75 percent loss rather than see the calls fall even further.

We’ll continue to keep our eyes on both rail traffic as a barometer of the domestic economy, and a future position in Trinity shares and calls as well.

 

Feb Retail Sales Confirm our Short Position in Simon Properties Group…

In addition to the Fed Rate hike, yesterday also brought the February Retail Sales Report. We shared our view on that yesterday, but in a nutshell, it was more pain for department stores and clothing retailers as well as those for electronics & appliances as Nonstore retail continued to take consumer wallet share. No surprise, given the commentary from the likes of hhgregg (HGG) and JC Penney (JCP), both of which have announced store closings, joining the ranks of Sears (SHLD), Kohl’s (KSS), and Macy’s (M). Surely Stella is going to put a crimp in March brick & mortar sales for retailers with heavy exposure to the Northeast, including Lululemon (LULU), Abercrombie & Fitch (ANF), and Urban Outfitters (URBN). What those all have in common is they tend to be mall-based retailers.

Simply another set of woes for mall REITS like our Simon Property Group (SPG). Even ahead of this, Morningstar Credit Ratings analyzed the commercial mortgage-backed-securities (CMBS) debt load on malls with exposure to J.C. Penney, and found that as a collateral tenant, CMBS exposure to J.C. Penney totals $16.43 billion. Remember JC Penney is closing 140 plus stores and that CMBS debt load doesn’t take into account other anchor store closings from Macy’s, Sears or some other.

While we’re up 7 percent in our Simon Property Group (SPG) short position, we will remain patient with this short position as we see far more to be had with brick & mortar retail pain. 

  • We have a Sell recommendation on shares of Simon Properties Group (SPG) and a short position on the Tematica Select List.
  • Our price target on SPG shares is $150 and we have a protective buy stop order to limit potential capital losses in this position at $200.

 

Feb Retail Sales also confirms our bullish view on United Parcel Service calls.

As we mentioned above, Nonstore retail sales continued to climb year over year in February and we simply see no slowdown in this shift as Amazon (AMZN) and others continue to expand their offering while brick & mortar retailers from Wal-Mart (WMT) to Under Armour (UAA) look to catch up.